Irelands Credit Rating Downgraded Again – Why are the Economists Surprised?

So Ireland has been downgraded by Standard and Poor from AA to AA minus. This is despite an international tour by the Central Bank Governor, Patrick Honohan, to tell investors that one of Ireland’s economies (the MNC export sector) is in healthy shape. Michael Taft has an excellent critique of this position here. International investors surely realise that Ireland’s export sector (measured in GDP – with profits grossly exaggerated – to take advantage of Irelands low corporate tax regime through transfer pricing) is relatively insulated from the wider real economy (measured in GNP). The real economy, the one experienced by most workers and businesses is still in recession. It is being deepened through active deflationary public policies and an unaffordable bank bailout.  Is it not time that we faced up to the reality of Irelands dual economy? Is it not time to stop relying upon Irish charm to wink and nod investors ? Is it not time for some serious analysis on the actual effects of Irelands austerity measures rather than its hoped for effects? Is it not time to debunk the myth of Irelands 1987 ‘cutback recovery‘? Is it not time to put away the ‘Ricardian equivalent’ models and get to grips with the biggest crisis facing the state – mass unemployment?

One does not have to be an economist to realise the current strategy is simply not working.  Economists cannot think outside their models. They make an important contribution to academic research but it is time for those grounded in the economy, the workforce and business to start steering the wheel.  This is an extended article I wrote  last week:

The Spanish government introduced a massive austerity package on the 27th May 2010 amounting to €15bn. The deepest budget cuts in the country for 30 years.   The following day the credit rating agency, Finch, along with others, downgraded its debt rating from AAA to AA+. This means that it makes it more expensive for them to borrow money on international markets. They are deemed to be less credit worthy. The Irish government has introduced two significant ‘austerity programmes’ and series of public sector pay cuts since 2008. The logic presented to the Irish public for implementing such pain was that it will improve our capacity to borrow money on financial markets. But, the premium we pay on our debt has actually increased.

If governments are cutting spending to reduce budget deficits, why are they being punished by the financial markets which they seek to borrow from and for whom they are cutting spending for? This is a serious question that has gone completely unnoticed in the current fetishisation of cutting fiscal deficits. The reason is because cutting government spending will not improve economic performance, growth or recovery.

Brian Coulton, Fitch’s person in charge of ratings for Spain said these exact words in a press release following the downgrading of Spanish debt: “The process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium-term.” He then went on to argue, like the OECD, that the primary problem in Spain’s economy is an over regulated and inflexible labour market.  The problem in the Spanish labour market is not its inflexibility but its lack of collective coordination across sectors. But, either way, the following fact remains: cutting budget deficits will not reduce the premium governments have to pay for issuing bonds. Financial markets reward growth not fiscal austerity. Cutting deficits, by definition and in fact, reduces economic growth. Cogito, cutting deficits in the absence of a clear growth strategy increases the probability of a further down grading of public debt.

This fact becomes more obvious when one examines why the Greeks had their debt downgraded to junk status in June. Despite a €110bn ‘pain for gain’ guarantee from the EMU/IMF recapitalisation package, Moody’s credit rating agency stated “Greece’s credit ratings will now depend on its future economic growth“. There it is in black and white. The question therefore is what will improve economic growth and unemployment? The strategy of the Irish government is based on three policies; stabilise the public finances through cutbacks, stabilise the banking system through a colossal bailout equivalent to 240.1% of GDP, and improve the ‘competitiveness’ of the Irish economy through a reduction in labour costs, primarily wage cuts. All of this will lead to a spiral of deflation and unemployment. It will not improve our borrowing capacity one bit.

Spain and Ireland will not return to growth because what was previously driving their economies has evaporated: real estate activity. Unless this collapse in private investment is replaced with something else quickly, the probability of a default and being priced out of financial markets increases. Budget cuts will make no difference to this scenario. The more important question therefore is what will create growth? Reliance upon the private market is an act of faith. Relying upon state or European wide coordinated investment is a rational choice. If the government can find €25,000,000,000 for one failed bank then surely they can find the resources to generate employment for the 400,000 + people out of work. This is a question of ideology as much as it is policy. The government of the state no longer considers job creation as central to its political mandate. It is proceeding with a failed liberal classical economic assumption that jobs are a by product of private wealth creation. We need a new coordinated jobs strategy.

If Ireland is going to default and go bust it is the cause of two factors: a massive state bailout of the private finance industry (primarily real estate banking), and a total collapse in revenue due to an over-reliance on regressive and unsustainable (indirect forms) of taxation. Austerity and massive cutbacks will not solve these problems.

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